Principal opens doors to niche bond market

Jim McCaughan, chief executive officer at fast growing Iowa, US-based Principal Global Investors (PGI), which manages $155bn (?133bn), is following in the footsteps of some of his much larger US competitors, who have achieved some successes and some failures on this side of the Atlantic. His goal is to increase his company’s share of third-party assets, particularly through a strong push into Europe. “Our clients tend to be, increasingly, open architecture wealth management platforms” says Mr McCaughan in his soft and calm voice over an early breakfast in London, where he typically squeezes in meetings en route from Australia back to the US.

This may seem like the same old marketing spiel of a dozen co-conspirators. But Mr McCaughan has hard evidence, which belies his unassuming manner. Through the office in London, opened just three years ago, Principal has grasped deals to manage money for a handful of European banks including ABN Amro, Merck Finck, part of the KBL Group, the Austrian Spangler and the pan-Nordic investment bank Kaupthing. “As the architecture in Europe becomes more open, we aim to become the favoured service provider to those open architecture providers,” states the Scottish-born CEO. Private banks, having both wealth management and fund platforms, represent 90 per cent of PGI’s European business.

Fixed income house

Despite recently developing strong equity investment capabilities, PGI is first and foremost a fixed income house, with bonds representing 60 per cent of US assets, followed by real estate strategies, for which they are the fourth largest US manager. As the asset management arm of the Principal Financial Group, the biggest provider of pension plans in the huge US 401(k) market for self-selected pension plans, PGI historically built its investment management capability for defined contribution plan clients. However, Mr McCaughan foresees that, although that business will carry on growing in terms of assets under management, the really rapid growth is going to come from their activities as a service provider, both to institutional funds and third-party distribution.

The products this US firm has been promoting, particularly in Europe, are mostly niche products, including preferred securities, which are fixed income instruments that behave more like equities. In fact, PGI prides itself as the only credible preferred securities provider in Europe, in addition to managing high yield bonds, real estate, mortgages and currency products. Mr McCaughan is confident that the phase of rapid changes characterising the European fixed income environment will favour the market penetration of their high added-value products.

“If you look at US fixed income, maybe 15 or 20 year ago, it was all investment grade and treasuries,” remembers Mr McCaughan. “Nowadays it includes high yield, mortgages, emerging market debt and lots of derivatives. It has become a much more complex area. Europe is going in the same direction and we believe that there are a number of fixed income managers and distributors in Europe that will have quite a voracious demand for the type of speciality of fixed income that we are good at”.

While a German office is soon to be opened, most of the business pulled into the London headquarters has come not from the UK, but from Continental Europe. “Up to now, our biggest success has been outside of the UK”, admits Mr McCaughan. “We have had more success so far in countries where fixed income and real estate products have been successful, which have been the Netherlands, Germany, Austria and, to an extent Switzerland and France, and then Nordic countries more recently.” But he is confident the UK market will open up to his group as distributors and intermediaries begin to recognise PGI’s increasing equity capability, in particular in US, Japanese, European and emerging markets (see table one). Tellingly, although PGI won a $160m US equity brief from a large European bank in November, neither partner in the deal is yet confident enough to discuss its specifics.

Traditionally reluctant

But Mr McCaughan says European banks are attracted to the non-commoditised nature of PGI’s products. This means that even those Continental banks traditionally reluctant to outsource bonds have assigned client monies to the US group’s fixed income funds. While PGI’s Dublin-registered preferred securities fund, despite being a narrower niche, has drawn in ?100m, its global aggregate bond fund, launched, also launched three years ago, has struggled to attract distributors’ interest. “This reflects the fact that European institutions, at least in the more straightforward category of fixed income, are not outsourcing yet,” says Mr McCaughan.

Clarity of purpose and the ability to be selective in product offerings are two key drivers of Mr McCaughan’s expansionist ambitions. “We are really recognising that in Europe the large local investment managers, and particularly the large banks, have very broad product ranges and our challenge is to come in with real added value niches. We will continue to be quite selective, we have no desire to be everything to a client,” he says.

This idea of providing a high quality, exclusive service, also extends to pricing. “We hold our preferred pricing and if they won’t pay it we don’t do it. We have a number of attractive speciality niches, which have enabled us to have that strategy. If you were selling lower fees products, I think that would be a different issue, but we are not doing that,” reveals Mr McCaughan.

PGI is happy to sell its funds across a variety of distribution systems. “Some of our business is white labelled, where the fund is sold in the name of the client,” says Mr McCaughan. “We are in as a provider, more often that not, in guided open architecture, though, but I think that is just a function of where the European market has got to.”